Do I need to pay tax on debt forgiveness?

August 10, 2011

From:  Wendy
Date:  25 Nov 2009

Hi Michael,

My friend purchased a condo 4 or 5 years ago for $310,000. She used it as a rental property. The market value of the condo kept decreasing each year and the renter failed to pay the rent. She couldn't make the mortgage payment.

The condo was sold in a short sale for $120,000 and the bank forgave the balance of the debt, about $280,000.

Does she need to pay tax on the debt forgiveness? If so, can she deduct the loss from the sale of the property?

Wendy

Answer

Date:  7 Dec 2009

Hello Wendy,

Your friend may have cancellation of debt income but also might qualify for an exclusion due to insolvency. She also might qualify to claim a deductible loss for the sale of the property.

I actually don't have enough information to answer your question, including whether the debt was recourse or non-recourse. For more information, see my article on Short Sales and Foreclosures at www.realestateinvestingtax.com/shortsale.shtml and IRS Publication 4681 at www.irs.gov/pub/irs-pdf/p4681.pdf. Your friend needs to consult with a tax advisor and possibly a real estate attorney.

Good luck!
Mike Gray

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